KEY POINTS:
A recent survey in the Economist devotes a dozen or so pages to an analysis of executive pay and, not surprisingly, notes that most of the public believe that top managers are paid too much and have too cosy a relationship with boards of directors.
This sentiment has
been fuelled by high-profile cases such as ex-Home Depot CEO Robert Nardelli, who received a US$211 million ($298 million) payoff when he lost his job, although shares had fallen slightly during his six years in charge.
Closer to home, Institutional Shareholders Services Australia director Dean Paatsch points out that while the resource boom delivered Rio Tinto shareholders a healthy total shareholder return (TSR) of 153 per cent since 2002, CEO Leigh Clifford's salary more than quadrupled in the same period. Similarly a recent three-year period saw Macquarie Bank's TSR grow 56 per cent while CEO Alan Moss's pay jumped 203 per cent.
The latter cases would no doubt be defended by arguing that the absolute value created for shareholders far exceeded the gains of CEOs. This argument has some merit, though of course questions can always be raised about what a "fair" share for CEOs is and what should happen in cases where value has not been created? A cynic would suggest that boards are more likely to roll out arguments blaming external factors and present "independent" consultant's reports justifying their courageous CEO not suffering at the compensation trough.
Perhaps most telling is that the Economist's survey cites research showing that discomfort with executive remuneration extends well beyond the public and vocal shareholder activists. One study finds that as many as 90 per cent of institutional investors share this opinion, along with 60 per cent of company directors. The latter is a startling figure given that these are the people with, apparently, the power and responsibility to set executive earnings.
Many activists argue that this state of affairs stems largely from a widespread failure of corporate governance and suggest legislation is required. They cite numerous examples of abuse of CEO power and/or abdication of directors' duties to back their call.
However, economic liberals prefer to view the transgressions highlighted by activists as aberrations in a system that works, in the main, and argue against increased government intervention. They take the view that rocketing executive remuneration is better explained by the greater emphasis placed on equity-based rewards such as options in recent decades,combined with an extended periodof economic prosperity.
The New Zealand Shareholders Association (NZSA) believes that government intervention would be both unfortunate and ineffective. However, we do take a stronger position on director and CEO responsibility than many economic liberals and agree that reform is required.
In most cases, particularly when shareholders are seeing their own wealth increase through dividends and share price growth as in recent years, it is not actually the quantum of compensation that enrages shareholders. It is lack of disclosure and willingness to discuss openly the logic behind the executive compensation package in question that reinforces suspicion of executive largesse and board/management collusion.
Perhaps more importantly, away from the high-profile cases of profligacy, a lack of transparency on executive pay means that shareholders are often left wondering if the board really has a clearly articulated set of measures that genuinely reflect the key drivers of value for the company.
While the broad market for executive talent and the ever-present consultant's reports on pay levels can't be ignored completely, when designing a compensation package one would expect at least as much emphasis on how a company performs across a range of relevant measures, in an absolute sense and against its competitors.
Shareholders have every right to expect a board that is managing its CEO competently and diligently to have such information at its fingertips and to use and disclose it appropriately. Sadly, our experience from attending AGMs and reading annual reports in New Zealand suggests that disclosure is sorely lacking, to an extent that cannot be justified by arguments about the protection of commercially sensitive information. This can only raise activists' concerns about whether boards are really doing their job or being ridden roughshod over by the executives they are supposed to manage or, worse still, colluding with those executives at the expense of shareholders and other stakeholders.
As stated earlier, the NZSA would not like to see new laws being enacted to achieve greater transparency in the realm of executive compensation. However, unless directors, management, auditors and consultants take a lead and disclose more relevant information in a timely manner, this may be the only option open to shareholders and other interested parties (eg, trade unions with members struggling to achieve wage increases in line with inflation to keep real wages static).